Why builders steer you to use their lender

This article concludes a three-part series that has appeared in HomesSaturday.

The first two articles in this series on referral fees dealt with situations where mortgage lenders were the referrers and collected the fees - from title insurance companies, appraisal management companies, mortgage insurance companies and others. The Real Estate Settlement and Procedures Act, or RESPA, which was enacted more over 40 years ago to reduce mortgage servicing costs swollen by referral fees, has been a colossal failure; settlement costs are as swollen today as they ever were.

RESPA has failed because it has left the referral power of lenders unchecked. Lender referral power could be eliminated by a simple rule that lenders had to pay for the cost of all services required in connection with a mortgage, embedding the cost in the price of the mortgage. This would eliminate referral fees and reduce settlement costs substantially. Sadly, this rule has no political constituency.

Referrals to lenders, as opposed to referrals by lenders, pose a different problem. Homebuilders are the principal source of referrals to lenders.

Since it is not possible to embed the price of a mortgage in the price of a house, there is no simple rule that would eliminate a builder's referral power. Homebuyers just have to learn how to deal with it, and hopefully this article will help.

Builder influence on lender selection

Builders cannot require that a buyer use a specified lender. However, the builder can require that the buyer be qualified by his preferred lender, and the builder can also offer inducements to use a preferred lender, provided it is done properly. A builder cannot post a sale price of $295,000 and raise the price to $300,000 if a buyer insists on using his own lender. But a builder can post a price of $300,000 and reduce it to $295,000 - or throw in $5,000 worth of extras - for borrowers who use the preferred lender. And that is a widespread practice.

Why builders have preferred lenders

In developing a strategy for dealing with a builder pushing a preferred lender, it is useful to know where the builder is coming from. He expects to be compensated by the lender for the referral of clients, often through a marketing arrangement where the lender pays some of the builder's marketing expenses. In addition, the builder expects the preferred lender to provide assurance that home sales won't fall through because of lack of financing.

The builder wants to avoid wasting significant marketing dollars in finding a buyer, who then leaves him at the altar because his loan doesn't come through. Under the arrangement between the builder and the lender, a loan to a buyer that can be closed only at a loss will nonetheless be made, since the profit margin on the house will more than cover the loss. For example, if the buyer turns out to have previously undisclosed credit problems that substantially reduce the price at which the loan can be sold, the in-house lender will make the loan and sell it at a loss.

To make up for these losses, other buyers are overcharged. Since builders cannot require buyers to use an in-house lender, they encourage them to do so by offering concessions that they hope buyers will value by more than the overcharge. For example, if the loan overcharge is $2,500, a builder might offer kitchen cabinets with a retail price of $3,000, but which only cost the builder $1,500.

A strategy for home shoppers

It is a mistake for a buyer to commit to a builder with an in-house lender without knowing the overcharge by that lender. The true price of the house when using the builder's lender is P + O - C, where P is the posted house price, O is the overcharge on the loan, and C is the value to the buyer of the builder's concessions. This is the price that should be used in comparing houses offered by different builders.

The extent of the overcharge on the loan should be measured in present value dollars by shopping one or more online lenders on the same day. If the selected loan is a 15-year fixed-rate mortgage that the builder's lender offers at 5 percent, add the sum of points and all other lender charges. The difference between this amount and the comparable figure on the same 5 percent loan offered by an online lender, such as those on my website, is the amount of the overcharge.

The value of concessions to the buyer could be less, perhaps considerably less, than the value suggested by the builder. If the builder's concession is to absorb some or all of the settlement costs, the buyer should check the alleged cost savings against those shown by online lenders.

In comparing true prices of different builders, buyers should give the builders ample opportunity to sweeten their concessions in order to make the deal. Especially in the kinds of soft markets that are common in early 2015, aggressive bargaining can yield a large payoff.

• Contact Jack Guttentag via his website at mtgprofessor.com.

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